Are we staring at a tech stock bubble?
- 26 March 2014
- From the section Business
The problem with bubbles on the stock market is that they're difficult to spot.
At any given time the bulls will have you believe there is still room for stocks to rise further, while the bears will say the opposite.
But one of the indicators of a bubble, say analysts, is when a huge number of firms that don't make any money look to sell shares and list on the stock exchange.
That is why the rush in technology and internet companies listing in the US - following the likes of Facebook and Twitter - is raising concerns.
On Tuesday, King, the firm behind the hugely popular Candy Crush Saga, was valued at more than $7bn after the company announced its flotation share price.
Unlike many tech firms, King at least makes money, and saw revenues rise to $1.8bn in 2013, from just $64m two years ago.
But the valuation still raised eyebrows among some analysts worried that King's Candy Crush phenomenon might turn out to be a one-hit wonder.
Ian D'Souza, a professor of behavioural finance at New York University, says the trend in tech flotations is beginning to look like the dotcom bubble of 2000.
"One of the great indicators of a bubble is when young companies are trying to access the capital markets in great quantities," he says.
"We've seen a proliferation of these at an accelerating rate over the past six months."
Mr D'Souza says that nearly 75% of recent stock market debuts have been from loss-making firms.
In the months leading to the 2000 stock market crash, 80% of initial public offerings (IPOs) were of loss-makers.
"It's not just a hot market, it's an ultra-hot market if you compare it with pretty much the biggest bubble of all time from an IPO perspective," he adds.
Betting on future?
Loss makers like Twitter, Groupon and Zynga have all raised cash in recent years, generating huge valuations as a result of their stock market listings.
Meanwhile other loss-making firms like Weibo - often referred to as China's version of Twitter - have also unveiled plans to raise hundreds of millions of dollars via share sales in the US.
But analysts say they are optimistic about these companies because they have built up substantial user bases and, if they can monetise that popularity, could start making profits.
Kathleen Smith of IPO investment advisory firm Renaissance Capital says the ability of firms such as Twitter to make a large amount of money is "further down the road".
"So investors are looking at that [and] saying: 'This company is worth this because I can see it has a business model to be able to grow its level of profitability. I am willing to pay this price with the assumption that this growth is going to prove out'."
Ms Smith adds that while the number of IPOs has risen substantially this year - there have been 53 listings so far in the US in 2014 raising nearly $8.5bn (£5bn) - that is still half of what we saw during the same period in 2000.
She also points to another key indicator - the performance of newly-listed shares on their first day of trading.
In 1999 more than 100 companies saw their share price double on the first day. In 2000 there were 80. So far this year there have been just four.
"That is the difference between what we are seeing now and a bit of the mania that happened in 1999-2000," she says.
She adds that the very fact that investors have become anxious over a bubble being formed was also "a good thing for the market".
But Mr D'Souza argues it is not the big name firms that are the concern, but rather the smaller firms looking to cash in on the optimism surrounding tech stocks as a whole.
He points to firms such as Facebook, Twitter and Alibaba which are either already making a profit or have a business model that is projected to make one.
But many lesser-known companies have been trying to "piggyback" on their success.
"So we have arguments like: 'This is the Facebook of China or the YouTube of Russia'," he says. "What you do from a psychological or behavioural point of view is that you anchor to these very successful well-known [names]."
He explains that such comparisons create the often-false impression that these firms will be as successful as the ones they are being compared to.
But Mr D'Souza says the biggest worry for him is that investors apparently recognise that bubbles are being created in the tech market, but seem willing to work within them.
"We are now trying to calibrate where we are in bubble cycles, rather than asking the question: 'Is the starting valuation correct?'," he says.